The opening acts of recession


We examine three unique trends that have historically coincided with the onset of recession and provide constructive context for investors.


October 19, 2023

By Sean Killin

Since the onset of major central banks’ monetary tightening campaigns in the first half of 2022, the probability of a recession has risen, and much attention has focused on certain risk factors that could portend a possible economic contraction. For example, RBC Wealth Management’s U.S. Recession Scorecard assesses seven leading economic indicators in order to gauge recession risks.

As interest rate hikes start to take their toll, like they are now, it’s also useful to examine three additional U.S. indicators that are typically consistent with conditions that exist at the beginning of or shortly before the onset of a recession. These are known as coincident recession indicators:

  • The steepening of the U.S. Treasury yield curve
  • Job losses over a three-month period
  • Deteriorating consumer confidence

In understanding these indicators, investors can become better equipped to manage risk exposure more tactically in portfolios while navigating the initial stages of recession.

Traversing a steepening slope

When recession risks start to increase, short-term yields rise higher than long-term yields, inverting the shape of the Treasury yield curve. In the current cycle, this started happening in July 2022 and was the yield curve’s first early warning signal of a potential recession.

As the economy subsequently weakens and the bond market responds to changing investor expectations regarding economic conditions, the yield curve tends to re-steepen towards a normal position.

In fact, the re-steepening of the Treasury yield curve into positive territory from an inverted position has historically proven to be the most reliable market indication of imminent recession risk. This typically happens one to two quarters in advance of a recession, but it can occur simultaneously or soon after the onset of one.

In the current cycle, the yield curve has just started to re-steepen, and will fully unwind its inverted state when it reaches above the zero line as depicted in the chart below. When this happens, this would be the yield curve’s second warning signal of a possible recession – an even more imminent warning.

In steep trouble

A steepening yield curve signals imminent recession

U.S. 10Y-1Y Treasury yield curve

Line chart showing the U.S. 10Y-1Y Treasury yield curve, which is the spread between the 10-year and 1-year Treasury yield, measured in basis points (or 1/100 of a percent). The chart dates from January 1970-September 2023 and captures eight U.S. recessions, which are identified in shaded grey bars. The chart shows that the yield curve typically inverts (1-year yield is higher than 10-year yield) roughly 11 months in advance of a recession and tends to steepen and “un-invert” at the start of or slightly in advance of the onset of a recession.

  • U.S. recession
  • U.S. 10Y-1Y Treasury yield curve (basis points)

Source – RBC Wealth Management, Bloomberg; monthly data through 9/30/23

The yield curve can steepen by different means. Recently, this process has begun with long-term bond yields rising faster than their short-term counterparts – a phenomenon known as a “bear steepening.” This tends to reflect resilience in the labour market and wider economy, and ultimately supports the case for keeping financial conditions tight or making them more restrictive.

We think this is signalling the bond market believes the U.S. Federal Reserve is likely to maintain higher interest rates for a longer period of time amidst broad resilience in the economy.

If the higher-for-longer rates scenario plays out, this would subsequently further raise net-interest expenses for businesses, ultimately placing additional pressure on corporate profit margins. A margin squeeze and restrictive financial conditions would likely weaken employment prospects and growth expectations, the typical precursors of recession.

The jobs market

Another signal of imminent recession would be when job losses begin to materialize – more specifically, when the three-month average of U.S. non-farm payrolls turns negative.

At present, the U.S. labour market remains robust, thanks to a still-elevated number of job openings underpinned by a healthy pace of job creation. The three-month average is pacing at +266,000 jobs, well above the negative level that would signal trouble.

However, it’s important to consider this indicator has turned negative very quickly in previous cycles, and it could change course just as fast in this one.

Outright job losses signal imminent recession

U.S. Non-Farm Payrolls

Line chart showing the trailing 3-month rolling average of U.S. non-farm payrolls, a measure which shows the net number of jobs added or lost in the U.S. economy measured in thousands of jobs. The chart dates from January 1970-September 2023 and captures eight U.S. recessions, which are identified in shaded grey bars. The chart is showing that the 3-month rolling average of U.S. non-farm payrolls turns negative at the start of or slightly in advance of the onset of a recession. At this time, this measure has declined meaningfully since the pandemic recovery, but seems to have steadied.

  • U.S. recession
  • U.S. Non-Farm Payrolls (3-month average)

Source – RBC Wealth Management, Bloomberg; monthly data through 9/30/23

A vote of (consumer) confidence

A third indicator that can signal the imminent onset of a recession is when consumers’ view of the current state of the economy deteriorates sharply relative to their view of the economy’s prospects six months from now.

This is a survey-based indicator, where perceptions can be influenced by human emotion. Nevertheless, it has been a reliable barometer in gauging the impact of slower growth, weaker labour markets, and tighter credit conditions on the real economy.

This indicator is depicted in the chart below as the view of economic conditions six months from now (expectations) minus the current view of the economy (present conditions). In the current cycle, the indicator has declined to the deep lows that have typically prevailed before the start of previous recessions. A sustained move higher would raise the likelihood a recession was underway.

Greener pastures?

Consumers more confident in future vs. present conditions?

Consumer Confidence: Expectations minus Present Conditions

Line chart showing the difference between consumer confidence in future economic conditions and present conditions. The chart is from January 1970-September 2023 and captures eight U.S. recessions, which are visually defined in grey shaded bars. The chart shows that when consumers start to increasingly believe future economic conditions are likely to be better than present economic conditions, then a recession is likely imminent. This is illustrated by an upward sloping line on the chart from a trough.

  • U.S. recession
  • Consumer Confidence: Expectations minus Present Conditions

Source – RBC Wealth Management, Bloomberg; monthly data through 9/30/23

In the clear … for now

None of these three coincident indicators are currently signalling that a U.S. recession is imminent. However, they bear monitoring because if one or some combination of them are triggered soon, that would indicate recession risks have increased notably, and more defensive portfolio positioning would be warranted.

This publication has been issued by Royal Bank of Canada on behalf of certain RBC ® companies that form part of the international network of RBC Wealth Management. You should carefully read any risk warnings or regulatory disclosures in this publication or in any other literature accompanying this publication or transmitted to you by Royal Bank of Canada, its affiliates or subsidiaries.

The information contained in this report has been compiled by Royal Bank of Canada and/or its affiliates from sources believed to be reliable, but no representation or warranty, express or implied is made to its accuracy, completeness or correctness. All opinions and estimates contained in this report are judgments as of the date of this report, are subject to change without notice and are provided in good faith but without legal responsibility. This report is not an offer to sell or a solicitation of an offer to buy any securities. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur. Every province in Canada, state in the U.S. and most countries throughout the world have their own laws regulating the types of securities and other investment products which may be offered to their residents, as well as the process for doing so. As a result, any securities discussed in this report may not be eligible for sale in some jurisdictions. This report is not, and under no circumstances should be construed as, a solicitation to act as a securities broker or dealer in any jurisdiction by any person or company that is not legally permitted to carry on the business of a securities broker or dealer in that jurisdiction. Nothing in this report constitutes legal, accounting or tax advice or individually tailored investment advice.

This material is prepared for general circulation to clients, including clients who are affiliates of Royal Bank of Canada, and does not have regard to the particular circumstances or needs of any specific person who may read it. The investments or services contained in this report may not be suitable for you and it is recommended that you consult an independent investment advisor if you are in doubt about the suitability of such investments or services. To the full extent permitted by law neither Royal Bank of Canada nor any of its affiliates, nor any other person, accepts any liability whatsoever for any direct or consequential loss arising from any use of this report or the information contained herein. No matter contained in this document may be reproduced or copied by any means without the prior consent of Royal Bank of Canada.

Clients of United Kingdom companies may be entitled to compensation from the UK Financial Services Compensation Scheme if any of these entities cannot meet its obligations. This depends on the type of business and the circumstances of the claim. Most types of investment business are covered for up to a total of £85,000. The Channel Island subsidiaries are not covered by the UK Financial Services Compensation Scheme; the offices of Royal Bank of Canada (Channel Islands) Limited in Guernsey and Jersey are covered by the respective compensation schemes in these jurisdictions for deposit taking business only.

Related articles

Life after sports requires a new game plan

Analysis 5 minute read
- Life after sports requires a new game plan

The U.S. fiscal stimulus uncertainty and the outlook for economic growth

Analysis 6 minute read
- The U.S. fiscal stimulus uncertainty and the outlook for economic growth

Are inflation fears inflated?

Analysis 6 minute read
- Are inflation fears inflated?